A federal appellate court has declined to expand the equitable intervention doctrine, a safety valve that has been applied to avoid unconscionable hardship that would otherwise result from strict enforcement of contract terms. ABA Litigation Section leaders recognize that equitable intervention is infrequently invoked to excuse noncompliance with contract terms but note litigators should be aware that most states recognize some form of the doctrine.
In Pizza Inn, Inc. v. Clairday, a franchisee paid $1,250,000 for the right to recruit and manage certain franchises in exchange for half of the royalty payments. After his initial contract term expired, the franchisee had the option to renew for two more five-year terms by giving written notice of his intent to renew at least six months before the current term’s expiration.
The franchisee’s second notice of renewal was two months late. The franchisor decided not to renew and sued for declaratory judgment. The franchisee counterclaimed, asserting breach of contract. A jury found in favor of the franchisee and awarded $250,000 in lost-profits damages.
The parties stipulated that the court, rather than the jury, would decide whether the renewal notice was sufficiently timely. The U.S. District Court for the Northern District of Texas applied the equitable intervention doctrine under Texas law to excuse the untimely notice, upheld the jury’s verdict, and awarded attorney fees in addition to damages.
The U.S. Court of Appeals for the Fifth Circuit reversed, finding that the district court erred in applying the doctrine because strict compliance with the contract terms would not cause unconscionable hardship. The appellate court began with the general rule that “an optionee is held to a strict compliance with the terms of the option agreement[,]” but explained that a “narrow equitable exception” applies upon satisfaction of a three-part test: “[1] the delay has been slight, [2] the loss to the lessor small, and [3] when not to grant relief would result in such hardship to the tenant as to make it unconscionable to enforce literally the condition precedent of the lease.”
The Fifth Circuit assumed that the first two factors were satisfied and focused only on the “unconscionable hardship” prong. It rejected the franchisee’s characterization of three claimed losses as “unconscionable hardship”: a “partial forfeiture” of the purchase price; a forfeiture of future profits; and “the shuttering of a Pizza Inn franchise store.”
Given the nature of an option contract, the franchisee did not forfeit any portion of his initial investment, the appellate court explained. The franchisee had paid consideration “for a legal power within a specified period of life.” When the time limit expired, he received the full benefit of the bargain.
Nor did losing “the opportunity to turn a profit” represent “extreme” or “oppressive” circumstances sufficient to “shock the conscience,” the Fifth Circuit held. Moreover, allowing lost profits alone to satisfy the third prong of the equitable intervention test would make a narrow exception applicable in almost every case. Finally, the appeals court observed that there was no evidence that the franchisor’s decision not to renew the contract caused the franchise location to close.
Ultimately, the Fifth Circuit concluded it was not clear that the equitable intervention doctrine “ha[d] []ever been applied beyond the context of a lease agreement.” However, it declined to decide whether the doctrine could apply to other types of option contracts.
Litigation Section leaders believe that the appellate court properly interpreted the equitable intervention doctrine’s scope. The doctrine has “very tight parameters,” explains Jason P. Kairalla, Miami, FL, cochair of the Section’s Appellate Practice Committee. “The notion of ‘unconscionable hardship’ suggests some significant imbalance in the parties’ status or bargaining position where the less advantaged party is suffering the poor outcome,” Kairalla continues. “This is generally the case in the landlord-tenant context where, as compared to the landlord, the tenant is often less sophisticated in business and may end up homeless if the renewal provision is strictly enforced.”
Additionally, real estate cases, “particularly those involving an option to extend or to purchase, present factual circumstances in which there is some investment that constitutes a real loss,” explains Paula M. Bagger, Boston, MA, cochair of the Section’s Commercial & Business Litigation Committee. Those cases involve a tangible loss “beyond the future income stream of perhaps continuing to do whatever you want to do, which is really all that the franchisee in Clairday lost,” she adds.
Although not frequently applied, “the concept [of equitable intervention] appears in the law of many states,” Bagger says. Different states take different approaches to applying—and labeling—this principle, however. “It is not called a ‘doctrine’ everywhere and not even called ‘equitable intervention’ everywhere,” she notes.
Litigators should determine “whether your state has a firm rule and how much wiggle room that gives you as a litigator,” according to Bagger. In some states, “courts tend to just say that a contract is a contract and adhere strictly to its terms, in other states, courts seem to waffle amongst the factors,” she explains. Either way, the doctrine is “a tool in the toolbox that you need to keep in mind,” Bagger advises.
